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Prior to the Great Depression, there was little regulation of banking institutions. The economic disaster that occurred in the 1930s, when hundreds of banks failed and millions of dollars in deposits disappeared forever, changed the view of the safety of banks.
In 1933, the Glass-Steagall Act was enacted, and the first safety regulations were announced. Shortly thereafter, in 1934, the Federal Credit Union Act was created to help ensure the safety of these institutions.
The FDIC (Federal Deposit Insurance Corporation) and the NCUSIF (National Credit Union Share Insurance Fund) were created to insure deposits, encouraging people and businesses to move dollars from their mattresses back to financial institutions. -
Federal and state regulatory mandates and examinations do not eliminate all risk to depositors and borrowers. These regulations help ensure the safety of banking operations, but guarantee little beyond the limits of deposit insurance protection.
While it would be foolhardy to deposit hard-earned money in banks, savings and loans (S&Ls), or credit unions that do not have federal (or state) insurance, people should still perform their own research into the safety - or lack thereof - of banking institutions. -
All insured banking institutions must report regularly to their agencies. This information is in the public domain, so people and businesses can access all financial and operating data on banks, S&Ls and credit unions on a quarterly and annual basis. One of the most important factors to evaluate: capital. The single most important factor in the safety level of banking institutions, its capital percentage says much about it projected stability during financial crises. A capital ratio of at least 7 percent to 12 percent is a strong indicator that the institution could survive in any economy.
Then there's ratio of loans to deposits and loans and loans to total assets. The higher the loan-to-deposit ratio, the fewer liquid assets (cash and short-term investments) are available for operation or withdrawal needs. While a high loan-to-deposit ratio generates the most income, lending all liquid assets may pose a safety problem.
A good loan portfolio mix is always encouraging as well. The mix should be diverse, with personal unsecured and secured, real estate, auto, commercial and line-of-credit loans. Over-concentration in one loan type may be a negative indicator of safety. -
The other general indicator of safety is more subjective and complex: operating strategy. Operating techniques and strategy are critical to long-term viability and profitability.
Use the Internet to locate expert third-party websites that offer information and analysis on operating practices and general safety quotient data. Learn about the banks and credit unions that handle risk better than others. These components contribute to the safety and soundness of banks, S&Ls and credit unions. -
Safe and sound policies, procedures and management quality of banking institutions are important to everyone. Even those institutions that have quality insurance only protect depositors' principal balances up to limits, currently $250,000. Federal insurance does not cover interest earned since the last account posting.
Because most bank safety problems stem from unsound lending practices, borrowers can encounter problems when lenders have financial issues. While specific loan terms in notes cannot be unilaterally changed, when a bank fails, other lenders often buy their loan portfolios. New owners have no personal relationships with borrowers and only want payments and fees to be paid on time, with little consideration for former unwritten agreements or understandings with borrowers.
